Puma Biotech: Wounded Predator Ready To Jump Back - Puma Biotechnology, Inc. (NASDAQ:PBYI)

Puma Biotechnology stock has dropped back to investable levels as the Q1 2019 sales disappointed and the out-licensing deals did not impress investors.

At the current price point, $13 per share, Puma is a buy - although risks are still high.

Puma Biotechnology (PBYI) has been a very volatile biotech stock in the last several years:

Last year, we published two articles about Puma with expected growth in the company's stock, Puma Biotechnology: Risky Investmentand Puma Biotechnology: Increasing Our Exposure.

In those articles, at the end of 2019, we valued Puma from $13 to $78 per share, depending on the M&A opportunity, pipeline news, and Nerlynx sales.

We had hedged our long position in Puma when the stock reached low $40s after Q4 2018 earnings release. And now we are long again as we think that the stock is significantly undervalued.

We think there was a series of mistakes on management's part that led to sell-offs and the possible exit of long term investors after the Q1 2019 earnings call, when the stock plunged from $32 to $13:

In our opinion, those mistakes include:

After reporting Q4 results on Feb 26, 2018, Puma's stock jumped to $40 from $26:

Nerlynx quarterly sales jumped from $53 mm to $61 mm:

Wall Street analysts increased their price target, and it became plausible that Nerlynx sales growth is back on track to become a $1 bn+ blockbuster.

All this euphoria may have led management to feel confident, or overconfident, that there is nothing they need to do in order to maintain the status quo.

Per multiple published literature, overconfidence usually shows up as an illusion of ability where people think they can do a better job of managing and predicting than they actually do.

This emotional and behavioral bias can lead to dire consequences - and the results of those consequences in Puma's case were the mistakes associated with the marketing of Nerlynx.

Puma has out-licensed most of its ex-US sales to various partners:

On the surface, the deals seemed to be incrementally positive, namely because they:

However, those presumed benefits were only on the surface. With every new deal announced, the stock was dropping.

And we think the explanation is fairly simple. Every new deal would decrease a chance for the acquisition of Puma by large pharma. In our previous articles, we analyzed that a fair acquisition value of Puma was around $75 per share - and that would include all the geographies and future indications.

With every new geography out-licensed, we think that the income pie for the would-be acquirer got smaller - large pharma is interested in leveraging its global presence and would prefer not to share the geographies with multiple parties.

Now, why didn't the management pursue M&A and instead chose to partner with smaller companies ex-US? It's possible there was no real bid for Puma, and the company had no other choice. But, our cynical intuition tells us that Puma thought it could build a successful and strong company on its own and the management will be able to retain its highly paid jobs. Again, this is our speculation, but the agency problem - the conflict of interest between shareholders and management - is not new, and we think that overall all the deals that Puma pursued were not in the best interests of shareholders (and the share price reacted accordingly).

During the Q1 2019 earnings call, management reported that it had insufficient staff to market Nerlynx.

At some point in Q1 2019, out of 80 sales rep positions, only 62 positions, or 78% were properly filled. And the explanation was given that it is very competitive to hire an oncology sales rep while demand in oncology marketing is rising.

We could also see that the SG&A expense for Nerlynx was not appropriate when we compare that to other oncology companies. Both in 2018 and 2019, SG&A expenses were 100% of sales:

While 100% seems to be an impressive figure, it actually pales in comparison to 200-300% of sales that other oncology companies spend in the first couple of years after launch. Tesaro (TSRO), Clovis (CLVS), and many others have spent an outsized amount of dollars on their respective launches given that oncology indications are highly competitive.

By definition, good sales reps would only work for a small oncology company if the compensation is higher than at large pharma. Moreover, if Puma had 80 positions available, it should have filled it out with 100 reps, instead of 62, as the importance of launch is much higher for a single-asset company like Puma than for a diversified company.

All the above reflects a larger problem of marketing a drug by a small-cap company with limited resources as compared to selling the company as a whole to large pharma and let the more experienced professionals do the job that they are better equipped to do from both financial and organizational perspectives.

So, generally, when we forecast sales of the drug, it is very important who is marketing the drug. Large pharma has better resources and capabilities to sell the drug than its mid- and small-size competitors. For example, it is possible that neratinib will max out in annual sales at $500 mm if that will be managed by Puma, but if neratinib is marketed by a company like Pfizer (PFE), the sales can reach $1 bn+.

Nerlynx is being studied in multiple sub-indications:

However, we think that the current indication, despite the associated side effects, is the most promising one in terms of revenue potential and absence of direct competition.

While many analysts believe that Kadcyla is competing with Nerlynx, we think Nerlynx is actually a logical continuation of treatment with Kadcyla (which is approved in the adjuvant setting, among others), with "extended adjuvant" label in the US.

With multiple studies ongoing, neratinib's potential label extension can help secure a blockbuster status if everything goes well. Usually, label extension is a much easier task than a new NDA itself.

While NCCN inclusion for neratinib is a big plus for a recently approved drug, the cautious language of the guidelines that warn about unknown toxicities after Perjeta or Kadcyla is becoming even more relevant as the discontinuation rate of neratinib seemed to be rising in Q1 2019:

Overall, though, we think that the CONTROL study with loperamide prophylaxis proves that diarrhea rates are manageable and can be significantly reduced:

Although we think that Puma has somewhat devalued the company with multiple out-licensing deals, we still think that a number of big pharma companies might still be interested in acquiring Puma with the US and Japan geographies the company still retained.

Pfizer and some other companies might be offering north of $50 per share, or a $2 bn deal for a drug that currently has $240 mm annual run rate, and can potentially score $1 bn (in the right hands), and can be immediately accretive for earnings, and with patent life beyond 2030. But it is unclear whether Puma management will be willing to sell and/or will be pressed by existing shareholders.

What makes the M&A consideration even more complicated is that Puma does not need cash in 2019. R&D expenses can be financed by milestone payments from ex-US partners, and SG&A expenses exactly equal the sales figures (this actually makes us wonder whether they specifically adjusted SG&A to sales).

So, theoretically, Puma's management can disregard what the market thinks about its performance and continue collecting its rich compensation and perform business as usual ... until some activist investor acquires a big enough stake to force the sell-out.

During the Q1 2019 earnings call, the management brought up the Medicaid rebates that led to lower net sales figures in Q1 2019:

A question to management: why didn't you cautiously consider Medicaid charges in Q4 2018? Why did you rush up to report 2018 net sales without properly accounting for possible bills?

The irony is that it's not the first time the management exaggerated its sales by overestimating the Nerlynx quarterly figures, as we pointed out in our previous article:

The overestimation of sales (we don't want to call it earnings manipulation because we believe it was not intentional) did not add to investor confidence as well.

The good news is that, presumably, neratinib growth is back on track with April's sold bottles increasing by about 20%, per management comments:

One can only guess what sales in May and June are. However, given that Puma has filled its empty rep positions in March, and given that the CEO has tirelessly participated in various healthcare investor conferences and projected confidence in neratinib current sales (at least what we could feel from the timbre of his voice), we assume that bottles sold in Q2 2019 can be something between 4,800 and 5,800 bottles, which would represent 8-30% QoQ volume growth.

We want to add here that Puma increased the list price of Nerlynx by 10% in Q1 2019, and that will be partially offset by higher (13% vs 9%) gross-to-net charges:

Overall, we expect the sales in Q2 2019 to be in the range of $50 mm to $65 mm, depending on how hard the sales team worked during the quarter.

The upper range, $65 mm, seems like a big jump from $46 mm in Q1 2019, but if we take into account price increases, seasonal uptick, absence of one-time charges to Medicaid, and presumed full sales rep capacity, then it is possible. At the same time, the lower range of our expectation is also quite possible as we've seen that the company has surprised investors in the past.

it's complicated. We still stick to our initial valuation hypothesis of $13 to $70 per share depending on the M&A perspective, pipeline progression, and Nerlynx sales.

After all, the company is currently valued at just $500 mm (or $13 per share), with commercially available $240 mm run rate oncology asset. The current valuation is much below the valuation of many early-stage oncology companies.

We believe that Nerlynx sales can be more than $1 bn if marketed by a highly experienced company with deep pockets. With M&A possibility in mind, we believe the appropriate price target is a mid-range of $13-$70, or around $40 per share.

Looking at the PBYI out-of-the-money call options for the rest of the year, it seems that the market simply does not believe in the positive movement of the stock.

For example, $25 strike price of a call with expiration in September has a market price of only $0.15 per share. For our portfolio, we think it is an attractive opportunity to invest in these calls if our valuation turns out to be true. Many well-known biotech funds invest in out-of-the-money calls and puts to manage their exposure (based on what we can see from SEC filings - only long positions are reported)

Yet, Puma remains a very risky investment - management is hard to predict, Nerlynx has Grade 3 toxicities that may or may not lead to higher discontinuations, and Puma's financial resources may be too limited to appropriately market its drug.

But like many investments in biotech, it is all about managing the portfolio's risks and returns, and Puma at this point has an interesting risk/return opportunity.

Disclaimer: This is not an investment advice. Please do your own research prior to making any investment decisions. This article represents our independent opinion and it cannot be construed as an investment advice.

Disclosure: I am/we are long PBYI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seekingalpha.com

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